COMPETITION AND INTELLECTUAL PROPERTY IN THE EUROPEAN UNION

COMPETITION AND INTELLECTUAL PROPERTY IN THE EUROPEAN UNION Claude CRAMPES Université de Toulouse- Gremaq and Idei David ENCAOUA EUREQua, Paris IAbraham HOLLANDER Université de Montréal

COMPETITION AND INTELLECTUAL PROPERTY

IN THE EUROPEAN UNION

Claude CRAMPES (Université de Toulouse- Gremaq and Idei)

David ENCAOUA (EUREQua, Paris I)Abraham HOLLANDER (Université de Montréal)

The contemporary economist views competition policy as “the set of policies and laws

which ensure that competition in the marketplace is not restricted in a way as to reduce economic welfare” (Motta, 2004, p 30) This perception of the role of competition policy has

not always been paramount in Europe Integration towards a single market used to be a centralobjective of competition policy Although the aforementioned present-day view of the role ofcompetition policy has been in ascendancy at the Community level and in Member Statesafter creation of the single market, European competition authorities still hold the view thatnational intellectual property rights hold back economic integration

According to Landes and Posner (2003, p 1) intellectual property consists of “ideas,inventions, discoveries, symbols, images, expressive works, … or in short any potentiallyvaluable human product (broadly, “information”) that has an existence separable from aunique physical embodiment, whether or not the product has actually been “propertized”, that

is brought under a legal regime of property rights” Therefore, intellectual property lawsrepresent the set of statutes, institutions and policies that grant, for a limited time, to authorsand inventors exclusive rights over the expression of their writings and intellectual creations(copyrights) or over the ideas themselves embodied in their technical inventions (patents)

To what extent is the existence of such exclusive rights compatible with competition?

In this regard it is key to note an important difference between the European Union and the

1 We thank Roger Clark and Eleanor Morgan for their insightful comments on a previous version (december 2004)

United States (Korah, 2001) Unlike the US, the EU grants no intellectual property rightsother than trademarks Patents and copyrights are granted under the law of Member States,complemented by the so-called European patent, created by the European Patent Convention(1973)2 currently signed by 28 contracting states According to Articles 2 and 3, a Europeanpatent granted by virtue of this Convention and covering one or more of the contracting statesshall have the effect of and be subject to the same conditions as a national patent granted by acontracting state Therefore, a European patent is just a bundle of national patents granted bythe European Patent Office (EPO) The EPO provides a one-stop shop that makes it possible

to get around the transaction costs associated with having examinations carried out inindividual states A patent granted by the EPO is recognized in a Member State if translatedinto the national language A proposal for a Council Regulation on the Community Patent(O.J 2000/C337 E/278) relying on the EPO, that would establish a single patent for the wholeEuropean Union, has not been adopted Although cases are litigated before national courts,the European Court of Justice (ECJ) has given Community authorities a powerful instrumentwhen it “drew a distinction between the grant or existence of a national intellectual propertyright, which was not subject to the Treaty, and its exercise, which was … The Court tookpower to override member states with respect to intellectual property rights that threatened todivide the common market along national boundaries” (Korah, 2001, 805)

Initially, the European Community had an inimical perception of property rights Theywere considered as impediments for the achievement of the common market “The ECJ usedthe distinction between the existence and exercise of property rights in the early 1970s todevelop a judicial doctrine of the Community exhaustion of intellectual property rights: once

a protected product has been put on the market by the holder … or with it’s consent in onemember state, the right was exhausted and a parallel intellectual property right could not beused to restrain the commercial importation of the product to another member state” (Korah,

2001, 805)

Things began to change in the 1980s (Encaoua et al (2003), Martinez and Guellec,

2003) The major role of intellectual property rights in stimulating innovation and growthgained greater recognition New governing bodies have emerged, for example the WorldTrade Organization (WTO), the World Intellectual Property Organization (WIPO), and the

2 Available at http://www.european-patent-office.org/legal/epc/

Court of Appeals for the Federal Circuit (CAFC) in the US.3 Moreover patent legislation hasentered a harmonization process across countries via bilateral and multilateral treaties.4

From a competition policy perspective it also matters that over the same period therehave been important changes in the motives that drive firms to obtain patents A number ofstudies point to the fact that firms increasingly file applications covering technologies that areneither developed nor licensed In some high-tech industries, firms seek patents for strategicpurposes, specifically, to exclude potential rivals (Carlton and Gertner, 2002, Cohen, Nelsonand Walsh, 2000, Hall and Ziedonis, 2001) For example the US semiconductor industrybuilds patent fences around core inventions One observes a proliferation of mutuallyblocking patents that coalesce into patent thickets that exclude potential rivals This comes inaddition to implicit threats of infringement suits that serve as bargaining chips to obtainaccess to other firms’ technologies or to force others to accept cross licensing arrangements(Shapiro, 2001, Encaoua and Hollander, 2002)

These practices raise a host of issues at the interface of IP and competition policy5.More specifically they may require a fresh exploration of areas where the grant of exclusiverights may shackle competitive market processes Two forms of competition should beconsidered: product competition and research competition Product competition yieldsallocative efficiency and gives consumers the opportunity to obtain products at prices that areclose to costs Research competition produces new products and new technologies It allowsfirms to escape the constraints of product competition, especially in neck by net industrieswhere firms have access to the same technologies and produce under the same costs (Aghion

et al 1997, 2001, Encaoua and Ulph, 2000)

However, market incentives may be insufficient to produce the optimal amount ofinnovation The standard modelling of competition under a competitive process does notaccount for important specificities Not only the outcome of R&D is uncertain as everyonerecognizes, but, more importantly, its output is an information good, i.e it is non rivalrous andnon excludable, except by legal means Granting the original inventor an exclusive right

appears as an ex ante incentive to innovate, inasmuch as it encourages investment in research

by avoiding free-riding Note that it is the ex ante incentive that matters for the purpose of

3 The Court of Appeals for the Federal Circuit has nationwide jurisdiction and hears specialized cases like patent and international trade cases See www.fedcir.gov

4 The agreement on Trade Related aspects of Intellectual Property Rights (TRIPS), which has over 140 members goes beyond the requirement that protection applies to foreign inventors as to domestic ones by also specifying a minimum set of rights that each member state must provide (see Scotchmer, 2004, chapter 11 “Innovation in the Global Economy”, 320)

5 For an overview of the tensions at the interface of IP and competition policy, see Federal Trade Commission (2003)

investment rather than the ex post reward to an inventor The ex post reward approach that is

prevalent among lawyers, would lead to the conclusion that since the investment cost isalready sunk, the exercise of the exclusive right has to be strictly scrutinized under the

competition law By contrast, an ex ante approach leads to the inverse conclusion that the

successful investor shall not be deprived from exclusive right to commercialise or sell

invention in order to keep the ex ante incentive to invest

Thus the grant of an exclusive right that limits competition in the product market ispart and parcel of a trade-off “Alike ordinary property rights that promote competition inproduction by preventing competition in consumption, intellectual property rights are a way(but not the only one) to promote innovation, by restricting some kinds of competition inproduction” (Vickers, 2001) Even so, later competition is encouraged because a patent isgranted on condition of disclosure of the knowledge that underpins the invention Thedisclosure favours the diffusion of know-how, allowing others to build around or improve onearlier inventions (Encaoua and Ulph, 2000) Protecting an innovation under secrecy does notallow such diffusion The dissemination of knowledge also benefits from licensingagreements and other arrangements such as the pooling of patents6 The latter also improvestatic efficiency because innovators are not always the best equipped to exploit existing know-how

Today many economists and legal scholars “acknowledge that analysis and evaluation

of intellectual property law are appropriately conducted within an economic framework thatseeks to align that law with the dictates of economic efficiency … Cases, doctrines andprinciples have to be examined from the standpoint of whether they are efficient in aneconomic sense and, if not, how they might be changed to make them efficient” (Landes andPosner 2003, p 4)

Still, as soon as one trades in the bliss of pronouncing on fundamental objectives forthe mundane pleasures of understanding the consequences of specific rules, it becomes plainthat there exist areas of stress between the two bodies of law The following sections showhow European courts have managed these stresses in three areas: (1) Parallel imports andmarket segmentation; (2) Refusals to supply essential inputs protected by patents andcopyrights; (3) Forms of conduct by copyright collectives

6 A patent pool is an agreement under which the owners of different technologies license them as a

bundle See Merges (1999), Carlson (1999), Lerner and Tirole (2002), Lerner et al (2003), Scotchmer (2004,

175-180)

1 Parallel imports and competition

Firms segment markets for efficiency reasons and in support of collusive agreements It isalso likely that they do so to gain a capacity to discriminate in terms of prices or qualities.Because intellectual property rights enhance right holders’ ability to segment markets, courtsare constantly required to balance a desire to protect the holders of patents, copyrights andtrademarks with a desire to give consumers access to products at competitive prices From aneconomic perspective, the issue is not merely one of trading off dynamic and static efficiency

In addition the issue is how, in specific cases, segmentation affects static welfare

With respect to international segmentation, there are specific issues related toexhaustion regimes (explain exhaustion regimes in footnote) and the legal treatment ofparallel trade Parallel trade takes place when products put into circulation in one country areexported to another country via distribution systems not set up, or consented to, by the partywho put them on the market first Parallel trade - also called grey trade - is not the same astrade in counterfeited goods7 Products that circulate in parallel trade are genuine They aregenerally marketed first by a person who holds the IPRs in these products, or by a licensee ofsuch person What sets parallel trade apart from ordinary commerce is the diversion ofproducts from the markets ostensibly targeted by the (delete) IPR holders

Parallel trade responds to cross-country price disparities.8 It limits the capacity offirms to segment national markets This means that from an economic perspective, restrictions

on parallel trade should be looked as devices that facilitate territorial segmentation

In the following, we start by recalling the incentives firms have to segment markets.Then we consider the view of the European institutions on the barriers to parallel trade; firstimports from outside the Union, then trade among Member States

1.1 Market segmentation: some theory

A firm with market power can increase profits by segmenting markets and engaging ingeographic price discrimination However, there is no unambiguous answer to the questionhow this will affect overall welfare Price discrimination brings about a welfare reducingmisallocation of output across markets but total output may be larger than under uniformpricing - possibly because additional markets are being served The latter is welfare

7 "Grey trade" means that the products are neither black, i.e counterfeited, nor white since they are sold against the will of at least one IPR holder.

8 The price gaps may be due to differences in demand elasticity or to divergent pricing by regulators across countries, as is the case of pharmaceuticals

increasing.9 Malueg and Schwartz (1994) have shown that when there is a large disparity inthe willingness to pay across national markets, a mixed regime of discrimination acrossgroups of countries differentiated from each other by substantial differences in willingness topay, but not among countries within individual groups yields greater world welfare thanuniform pricing on a global scale.10

A capacity to discriminate may be necessary to insure that profits are positive Thisapplies mainly to industries where fixed costs are very large compared to variable cost Onethinks of industries that rely heavily on R&D or other creative effort The argumentessentially boils down to the claim that in certain industries, a mere right to exclude conferred

by intellectual property law does not insure that returns are sufficient to elicit a sociallyoptimal level of innovation

In this regard it is important to stress that economic theory does not give anunequivocal answer to the question whether a switch from uniform to discriminatory pricingincreases industry profits when firms confront rival producers While it is true that each firmbenefits from acquiring a capacity to discriminate, it loses when rival producers obtain thesame capacity The net effect on profits depends on the intensity of the rivalry Allowingdiscrimination intensifies competition in market segments where buyers view the products ofdifferent producers as good substitutes, but, at the same time, it allows firms to capture largerprofits in market segments that have a strong preference for their particular variety.11

It is not always the desire to discriminate that steers firms towards marketsegmentation Manufacturers may grant distributors exclusive territories to encourage them toinvest in promotional activities such as presale information, product advertising and qualitycontrol In the absence of exclusivity, the investment by one distributor benefits rivaldistributors Distributors that do not invest could attract customers who have already soughtinformation from distributors who do invest, by undercutting them The very fact that theircosts are lower gives them this option The result is that each distributor has less incentive toinvest than is optimal from the manufacturer’s perspective To address this problem themanufacturer may take measures that reduce the likelihood that buyers in a territory allocated

to one distributor would be served by distributors in another territory

9 When additional markets are being served, consumers in these countries will benefit and consumers in countries that would have been served under uniform prices need not lose.

10 Adoption of such policies would, however, run afoul of importers’ most favoured nation obligations under WTO rules WTO membership does limit (allow?) a country’s freedom to choose its policy with respect to parallel trade However, it requires the country to abide by the most favoured nation rule regardless of the policy

it chooses

11 The relevant literature is reviewed in Stole (2004) See also Encaoua and Hollander (2004)

While the alignment of distributors’ and manufacturers’ incentives is likely to bewelfare enhancing, it could come at a cost For example, the elimination of downstreamcompetition can lead to double marginalization.12 This reduces manufacturers’ profits andconsumers' welfare It also reduces interbrand competition Rey and Stiglitz (1995) haveshown that the latter is due to the fact that distributors with market power do not fully pass on

to their buyers increases in the wholesale price Therefore the demand faced by manufacturers

is less elastic than it would be if distributors were in competition The outcome of thereduction in elasticity can mirror collusion13

Manufacturers adopt a variety of measures to curtail grey trade and enhance theircapacity to profit from price discrimination They sometimes put quotas on the quantitiesdelivered in a national territory.14 At other times they limit the coverage of guarantees to theterritory where the product was first put into circulation Every so often, they use technicalmeans that preclude use in one country of an article originally sold in another territory.15 Attimes, they try to create in the mind of consumers residing in high price countries, the beliefthat grey goods are counterfeit, pirated, (omit comma) or of lesser quality.16

The laws that protect intellectual property provide another avenue for thesegmentation of national markets A central issue concerning intellectual property protection

is which rights are relinquished upon the first legal sale of a product in which rights areinitially held Consider, for example the case of CDs containing music Composers, publishersand, possibly, makers and performers hold initial rights in the music as well as in the CD thatcontains the music However, upon first sale of the CD they lose the right to prohibit its

12 That is both the manufacturer and the distributor set price above marginal cost.

13 Gallini and Hollis (1999) give a detailed overview of the pros and cons of market segmentation, focussing on the restrictions on parallel imports achieved via trademark protection

14 See Crampes, Hollander and Macdissi (2004).

15 For example, the international distribution of films on DVD has been technologically and legally segmented into geographical markets The regional coding system requires that all DVD players be manufactured for distribution and use in one of six geographic regions around the world It is a global initiative by agents of the film and DVD industries aimed at preventing the free movement of licensed copies of copyright DVDs around the world Dunt, Gans, and King (2001) have studied whether the restrictions on DVD usage across regions can

be justified as a means of generating potentially socially desirable price discrimination for content providers or are simply a means of restricting competition They conclude that "the conditions that may theoretically allow such restrictions to be efficient are unlikely to hold in the case of DVDs and that social welfare is likely to be significantly enhanced by eliminating such technical restrictions." (not italic, add page ref.) Their argument is that among the four potential consequences of such restrictions on regional flows (price discrimination, collusion, free-riding, and the prevention of consumer confusion), the latter two -potentially socially desirable- consequences are unlikely to be important

16 However, in some instances a moderate amount of parallel imports may actually benefit a manufacturer See Anderson and Ginsburgh (1999).

resale That right has been exhausted.17 In the discussion below, exhaustion of a right willalways refer to the loss of the right to control reselling

IPRs are territorial The right to control a particular use of protected material appliesonly within the national boundaries of the jurisdiction that grants that right This appliesequally to the exhaustion of rights, i.e., (omit commas) the national law determines underwhat circumstances a right holder – resident or foreigner – exhausts the right to control resale

in the national territory

There are several exhaustion regimes Under a regime of national exhaustion, theperson holding the IPRs (delete s) in a product waives the right to prohibit resale of thatproduct in the national territory upon the first legal sale within the boundaries of thatterritory.18 In countries that accept international exhaustion, the original right holder forfeitsthe power to control resale within the (delete the) national boundaries as soon as the product

is legally put into circulation anywhere in the world

The particular regime a country chooses may vary from one type of IPR to another.For example, a country may adopt international exhaustion in the case of trademarks andnational exhaustion for patents Furthermore, regimes may occasionally be product-specific.The exhaustion regime a country chooses always reflects a somewhat uneasy balancebetween, on one hand, a desire to protect the interest of IPRs (delete s) holders, and on theother hand, the wish to guarantee consumers and businesses the opportunity to make informedpurchases in a competitive environment

In the following, we discuss the approach of the European Union towards parallelimports from a perspective of competition policy The EU makes a distinction betweenparallel trade between Member States and trade between the Union and non-members Themost important difference between the EU and other jurisdictions is the adoption by theformer (delete) of a regime of regional exhaustion under the Trade Marks HarmonizationDirective.19 Article 7 of the Directive prescribes a regime under which the owner of a

17 Some of these rights holders can still prohibit certain uses of the CD For example, they can forbid the CD’s performance on radio or in any public place The reason is that the right to perform in public the music fixed on the CD is not exhausted upon the first sale of the CD.

18 This assumes that the goods have not been altered after they have been put on the market by the owner of the

trade mark or with his consent Repackaging is not per se forbidden; see Commission Communication on

parallel imports of proprietary medicinal products – frequently asked questions, MEMO/04/7, Brussels, 19th January 2004.

19 The Directive was adopted in 1989 (89/104 (EEC) 21 December 1988) but became effective only in 1996 “A trade mark may consist of any sign capable of being represented graphically, particularly words, including personal names, designs, letters, numerals, the shape of goods or of their packaging, provided that such signs are capable of distinguishing the goods or services of one undertaking from those of other undertakings.” (article 2) The objective of a trade mark is to help buyers to identify the source of products This gives producers the incentive to improve quality.

trademark cannot avail himself of the right conferred by trademark law to prevent the saleanywhere in the EU of a good marketed first by him or with his consent in any territory of theEuropean Economic Area This, however, ceases to apply when the proprietor of thetrademark has legitimate reasons to oppose further commercialization, especially when thecondition of the goods is changed or impaired after they have been put on the market Trademark rights in Member countries are not exhausted by first circulation of the product outsidethe EEA.20

1.2 Grey goods originating outside the EEA

The conditions under which exhaustion of right conferred by trade marks occurs have beenclarified in several decisions rendered by the European Court of Justice (ECJ)

In the Silhouette case, the ECJ ruled that a Member State could not adopt a widerexhaustion regime than set out in Article 7 of the Trade Mark Directive This was founded inpart on the wording of the Directive, and on the observation that “if some members practicedinternational exhaustion and others did not there would be barriers to trade, and this wouldaffect the functioning of the internal market, and this is precisely the objective pursued by theDirective”.21

The notion of consent received further (delete) elucidation in the subsequent (delete)Sebago judgment in which the ECJ rejected the validity of an importer’s claim that thetrademark holder exhausted his right to prevent the sale within the EU of all batches of a goodonce he had consented to the marketing of a single batch of identical goods.22

20 Before the Directive went into effect, most EU countries operated under international exhaustion A concise review of the history of the Directive appears in Trogh (2002) Although the exhaustion regime is mainly applied

to trademarks, it also concerns the topography of semiconductors (article 5(5) of Directive 87/54/EEC), patents (art 28 of Agreement 89/695/EEC), biological inventions (article 10 of Directive 98/44/EC) and designs (article

15 of Directive 98/71/EC) The European Court of Justice applied the principle to copyrights (Cases 55/80 and

57/80 Musik-Vertrieb Membran GmbH and KKK-Tel International v GEMA ) and to patents (Case 15/74

Centrafarm v Sterling Drugs) Our focus here is on the competition issues raised by the protection afforded by

22 The case involved a suit brought by the owner of the Sebago trademark against a Belgian firm that imported shoes from the Salvadorian manufacturer of the genuine product for resale under the original label The claimant argued that the importer had infringed his trademarks because he had not received consent to market the shoes in the EU.

The meaning of consent was also at the heart of the later Davidoff and Levis cases 414/99 to C-416/99) The ECJ held that consent cannot be inferred from the absence ofcontractual provisions or communication to that effect, or from the fact that the goods carry

(C-no warning that sale outside a specific area is prohibited The ECJ held that consent requires

an unequivocal demonstration of renunciation of one’s right to oppose importation into theEEA

While the aforementioned decisions bear on the question whether trade mark law can

be used for blocking parallel imports into the Union, they do not address the question whethercontractual provisions between private undertakings that commit one party to sell only inassigned territories outside the EU are prohibited This question was addressed by the ECJ inresponse to a question raised by a French court The case involved proceedings brought byYves St Laurent Parfums (YSLP) against Javico The perfume manufacturer had entered into

a contract for the distribution of its products in selected territories outside the EEA Thecontract provided that the distributor would not sell the product outside these territories or tounauthorized dealers in the territory When YSLP discovered that products sold to Javicowere marketed in several countries of the Community, it broke the contract and started legalproceedings When a French court upheld both termination of the contract and its claim forcompensation, the defendant appealed on the ground that the controversial contractualprovision was prohibited by Article 85(1) (now 81(1)) and therefore automatically void

The ECJ ruled that in order to determine whether agreements such as the oneconcluded between YSLP and Javico run afoul of Article 85(1), one must consider whethertheir purpose or effect is to restrict to “an appreciable extent competition within the commonmarket and whether the ban may affect trade between Member States”.23 The Court held thatagreements could not be struck down unless they were capable of affecting trade betweenMember States The ruling it handed down was that the provisions at issue “did not constituteagreements which, by their very nature, are prohibited by Article 85(1)” (paragraph 21 of thejudgment) It remained for the national court to determine whether they did in fact have sucheffect.24

23 Case C-306/96, Javico International and Javoco AG v Yves Saint Laurent Parfums SA, 28 April 1998.

24 The Court said that a violation may take place “where the Community market in the products in question is characterized by an oligopolistic structure or by an appreciable difference between the prices charged for the contractual product within the Community and those charged outside the Community and where, in view of the production and sales in the Member States, the prohibition entails a risk that it might have an appreciable effect

on the pattern of trade between Member States such as to undermine attainment of the objectives of the common market” (paragraph 28 of the judgement)

The significance of the Javico ruling may be rather limited in view of the ECJ’sdecision in Davidoff and Levis A possible consequence of the latter is that firms concernedabout the importation of their trademarked products into the EU will find such prohibitions asimposed on Javico redundant.25 This would be true all the more if it was determined thatinternational exhaustion applies in circumstances where contractual measures designed toprevent importation into the EU contravene Article 81 or Article 82

1.3 Partitioning of the EU into national markets

The stance of competition authorities with respect to territorial restrictions that restrain greytrade within the Community appears less flexible The courts have held that an agreementwhose object it is to prevent grey trade within the Community is by its very nature a violation

of Article 81(1).26 This means that in order to find a breach of Article 81(1) it is sufficient toshow: i) that the measures taken amount to an agreement; and ii) that the object of theagreement is to prevent parallel trade within the Community The following decisionsillustrate the point

Yamaha27 sold instruments through a network of official dealers located in various EUcountries It signed contracts with its dealers that bound the latter to the following: 1) sellsolely to final customers; 2) buy solely from Yamaha’s national subsidiary; 3) supply solelydistributors authorized by the national subsidiary, and 4) contact Yamaha Europe in Germany,before exportation via the Internet.(close gap)28 In addition, the guarantees issued by Yamahawere in effect only in the country of original purchase of the instrument they covered.29

Furthermore, the contract between Yamaha and its Icelandic dealer contained an explicitprohibition of parallel trade

The Commission concluded that commitments to sell exclusively to final consumers,buy solely from Yamaha’s national subsidiary and supply solely distributors authorized by thenational subsidiary had the object of preventing cross-supplies within Yamaha’s dealernetwork.30 It reached this conclusion by examining the possible consequences of theaforementioned provisions The Commission also argued that "although the object of the

25 Unless such provisions allowed the owner of the trade mark to claim damages for infringement that would otherwise not be awarded.

26 For example, in the (delete) Case IV/35.733 – VW, “(t)he obstruction of parallel exports of vehicles by final consumers and of cross-deliveries within the dealer network hampers the objective of the creation of the common market, a principle of the Treaty, and is already for that reason to be classified as a particularly serious infringement.”

27 Commission Decision of 16.07.2003, Case COMP/37.975 PO/Yamaha.

28 The details of the contractual provision differed to some extent from one country to another but their essence was very similar.

29 The contracts also contained provisions that restricted the dealers’ pricing policies.

agreement (to contact Yamaha before exporting) may not have been to directly restrictexports, it clearly had the potential effect of discouraging dealers from exporting products toother Member States." (Paragraph 109 of the decision) Interestingly, the Commission did noteven broach the question of object or effect in regard to the Icelandic contract It simplyinvoked the ruling without considering Yamaha’s claim that, given Iceland’s remote location,

it was unlikely that the contractual clause would in fact restrict trade.31

The question which kind of conduct is required to create an agreement within themeaning of Article 81 was at the heart of the subsequent Bayer case The local distributors ofthe pharmaceutical firm had signed contracts that included provisions that were designed toeliminate grey trade among Member States The European Commission held that there existed

an agreement between Bayer and its dealers and fined Bayer (by how much?) (96/478/EC) Itsfinding was based on the observation that the dealers had continued their business relationshipwith Bayer, and, in response to the contract, had adapted the way they placed orders TheCommission noted but did not discuss the implications of the fact that in response to Bayer’smeasures the wholesalers put together their orders as if the product they received would serve

to meet only the demand of their national market, and that they did their best to inflate thenational quotas imposed on them by Bayer The evidence examined by the Commission alsoshowed that wholesalers tried to get additional quantities by ordering from other, generallysmaller, wholesalers who were not monitored by Bayer

The Court of First Instance (CFI) overturned the Commission’s decision (2001/C95/13) It held that the Commission had erred by considering that it had established theexistence of a concurrence of wills between Bayer and the dealers And, the mere absence ofsuch concurrence meant that there was no agreement within the meaning of Article 81(1).32

The CFI argued that the Commission was wrong in concluding that the reduction in orderscould only be understood by Bayer as a sign that dealers had accepted its demands TheCommission could not maintain that the reason wholesalers had to order additional quantitiesfrom other dealers was because they agreed to Bayer’s demands The CFI opined that these

30 It also noted that under settled case law there is no need for the purpose of application of Article 81(1), to show an actual anti-competitive effect of agreed conduct whose object it is to restrict competition within the Common Market.

31 The Javico ruling mentioned in section 1.2 states that “an agreement which requires a reseller not to resell

products outside the contractual territory has as its object the exclusion of parallel imports within the Community and consequently restriction of competition in the common market Such provisions, in contracts for the distribution of products within the Community, therefore constitute by their very nature a restriction of competition." C-306/96, paragraph 14.

32 Remind that establishing the existence of a potentially anticompetitive agreement relieves the Commission of the obligation to show an effective or probable lessening of competition as a result of the agreement

orders were not indicative of the fact (delete) that wholesalers did acquiesce.33 It alsoexplained why Bayer’s behavior justified a decision at variance with the earlier Sandoz ruling

in which it had determined that an agreement existed.34 Sandoz had on repeated occasionsindicated on the bills sent to its clients that export of the goods was prohibited The fact thatits distributors had continued to order without protest and had de facto respected the banmeant that they had tacitly acquiesced to Sandoz’ terms However, whereas Sandoz had put aspecific anticompetitive clause in the contract, a formal prohibition to export was lacking inBayer Furthermore, Bayer had not implemented a systematic monitoring of the finaldestination of the product and there was no evidence that the manufacturer had threatened orpunished a wholesaler who exported, or made the delivery of product conditional onwholesalers’ compliance with the alleged export ban

The ECJ upheld the CFI's judgment (C-2/01 P and C-3/01 P delivered on 6 January2004) It indicated that while existence of a monitoring system and penalties may amount to

an indicator of an agreement, they do not prove its existence The Court emphasized that themere fact that Bayer imposed a quota that may have had the same effect as an export ban,does not imply it had imposed a ban, or that there existed an agreement The Court stressedthat the concurrent existence of an agreement that is neutral from a competition standpointand a measure restrictive of competition that is imposed unilaterally does not amount to aviolation of Article 81(1) Because there had been no claim that Bayer was dominant, the need

to examine whether Article 82 had been violated did not arise

The decision in Bayer does not fully answer the question whether unilateral behavior

by a dominant actor designed to rein in parallel trade would be treated by competitionauthorities in the same way as other potentially abusive forms of conduct.35 The answer to thisquestion ultimately depends on how competition authorities and the courts viewdiscriminatory practices, in particular price discrimination It appears that exemptions to theprohibition of price-discrimination by competition authorities are rare (reference for this?).This is somewhat surprising in view of the fact that there is no basis in theory for a claim thatdiscrimination is more harmful to the competitive process than the other forms of conductmentioned in Article 82

As indicated at the beginning of the section, the economic literature points to severalcircumstances under which price discrimination yields higher welfare than uniform pricing

33 This begs the question whether some forms of cheating on a mundane price-fixing cartel could similarly protect a participant from being accused of tacit collusion

34 Sandoz Prodotti Farmaceutici/Commission ( C-277/87, rec P.I-45)

35 After all, restrictions of parallel trade go against a fundamental objective of the Treaty of Rome which is integration of national markets.

Even from a consumer welfare point of view one cannot argue that discrimination alwayslacks redeeming value Furthermore, the empirical evidence on the price effects of paralleltrade within the European Union remains sparse Some analysis suggests that the rentscaptured by parallel traders exceed the benefits to consumers in countries that import viaparallel channels and consumer gains are small or moderate.36 This and the fact that paralleltrade consumes resources would suggest that grey products may affect welfare adversely ornot at all One must admit, however, that at this stage it is not clear yet (delete) whether some

of the(delete) assumptions underlying the conclusion that consumers in the EU draw littlebenefit from parallel trade, are critical to that finding.37

2 Refusals to supply an essential intellectual property right

Rights of exclusion differ according to category of IP A patent owner can prevent othersfrom making, using or selling the patented invention for a period of 20 years from the date ofissue of the patent Copyright protection which applies to original works of authorshipembodied in a tangible medium of expression normally expires in the European Union 70years after the death of the author Unlike a patent, a copyright protects only the form ofexpression It does not protect the underlying idea This means that a right holder in a work

“a” holds no rights in an independently created work “b” based on a similar idea Tradesecrecy protection applies to information whose commercial value depends on non disclosure

Of course, trade secrets have no expiry date and they do not provide a legal barrier that stopsothers from independently producing and using the same invention

From an intellectual property perspective, one’s right to exclude others is key.Competition authorities do of course recognize the right to exclude since it is granted underpatent and copyright laws Their concern arises when that right protects an input that isindispensable to another party They may consider that a refusal to licence an essential input

is abusive when it prevents competition This creates a potential for friction betweenintellectual property law and competition law

36 See Ganslandt and Maskus (1999) and NERA (1999).

37 Nevertheless European Competition authorities seem to take a particularly dim view of restrictions designed to prevent arbitrage In the words of the Director General of DG Competition at the Commission "… sales restrictions may be used to prevent arbitrage and support price discrimination between different markets This will in general lead to a loss of consumer welfare While some consumers will pay a higher price and others will pay a lower price, collectively consumers will have to pay more to finance the extra profits obtained by the supplier and to cover the extra costs of supporting the price discrimination scheme Therefore consumer welfare will in general decline unless it can be clearly shown that otherwise the lower priced market(s) would not be served at all and that therefore the price discrimination will lead to an undisputable increase of output It's only in

the latter case that consumer welfare may actually increase." See Lowe (2003).

According to the essential facilities doctrine a firm holding a dominant position in theprovision of an input that is indispensable for the production of another good that competeswith the good in which the firm is dominant, acts abusively when, without objectivejustification, it refuses to supply the input The application of this doctrine must obey tostringent conditions: i) the facility must be under the control of a dominant firm; ii) theaccess to the facility is unavoidable to allow a competitor operate in a downward market; iii)

it is practically impossible to duplicate the facility; iv) the access to the facility by competitors

is technically feasible under standard safety rules; v) the plaintiff is willing to accept thestandard commercial terms and vi) the refusal to supply access to the facility has no objectivereason Despite the severity of these requirements, it seems that competition authorities indifferent countries have often be too ready to apply the essential facilities doctrine, mainly inthe case of natural monopolies such as utilities and transportation services38

The application of this doctrine is much more difficult when the so called essentialinput is related to an intangible asset In principle, firms that produce patented or copyrightedinformation goods and wield substantial monopoly power are not shielded from antitrustliability However, it is only in exceptional circumstances that courts in the EU and the US,have invoked the doctrine This raises the difficult question of whether licensing should bemade compulsory in some circumstances

2.1 The economics of compulsory licensing

Gilbert and Shapiro (1996) argue that conditions such as the ones listed above cannot

by themselves justify compulsory licensing on economic grounds: “These conditions do notcharacterize the circumstances under which compulsory access to a facility or to intellectualproperty would be beneficial to economic welfare A firm may choose to deny access to anactual or potential competitor … for many different reasons These include reasons that arelikely to enhance economic efficiency” Preventing free riding that would diminish incentivesfor investment and innovation, preserving a desired level of service quality and designingappropriate contracts that compensate the intellectual property owner for the loss of revenuethat may result from access may justify the refusal to deal Still one cannot dismiss a purestrategic motive behind a refusal to license Therefore, a detailed inquiry on a case by casebasis is needed to analyze the consequences of a refusal to license an essential intellectualproperty right The inquiry must take into account the economic conditions under which

38 A useful introduction to the essential facility doctrine can be found in Temple Lang (2000) Different illustrations related to the transport sector under EC competition rulings are given in Motta (2004, note 53, ch.2).

welfare would be diminished if access to the facility was denied (Katz and Shapiro, 1985,Gilbert, 2000, 2002, 2004, Scotchmer, 2004, Maurer and Scotchmer, 2004)

On economic grounds, the short run effects of a refusal to license depend on how theprice of the license is determined Under a fixed fee regime, if the competitor had access tothe IPR, its decisions would not be affected by the value of the fee The fixed-fee license doesnot change the market outcome and its effect is purely distributive But even in this case, theeffect on welfare of an order to license depends on the licensee’s efficiency If the licensee isnot very efficient or at least less efficient than the patent’s holder when using its proprietarytechnology, an order to license is detrimental to economic welfare However, there are alsosituations where licenses to efficient competitors could be optimal but are not voluntary It is

in these situations that compulsory licensing is welfare improving in the short run

Under a royalty regime with royalties linear on units supplied, the outcome maydepend on whether the patent holder does produce or not himself If the patent holder does notproduce, linear royalties combined to fixed fees are sufficient to support the profit maximum(Scotchmer, 2004, 187-189) In this case licensing is based on private incentives and theremay be no scope for compulsory licensing But when the patent holder is also a producer, thesituation is different since a linear royalty leads to an inefficient outcome, except if thelicensee is more efficient than the patent holder One solution to this problem could be either

to impose a royalty rate that is a decreasing function of the licensor’s output or to cap thelicensor’s output by imposing a maximal bound (Maurer and Scotchmer, 2004)

Since the proponents of compulsory licensing only require that the royalty bereasonable and do not propose a certain payment formula, it is difficult to assess the short runconsequences of a compulsory license for economic efficiency

An obligation to license also affects long run incentives to invest in R&D Considerthe case where investment in R&D is represented by a bid for an innovation produced by anupstream laboratory Gilbert and Shapiro (1996) identify two adverse effects of compulsorylicensing “First, a compulsory license reduces the profits of the winning bidder by forcing thewinner to license in situations where it is not privately rational to do so Second, compulsorylicensing is likely to lower the value of the winning bid because it increases the profits of thelosing bidder Under compulsory licensing, the losing bidder is assured that it will benefitfrom the innovation, assuming the owner of the technology is compelled to license thetechnology at a price that the licensee would be willing to pay The size of the winning bid isdetermined by a firm’s value of owning the technology, less the value to the firm if thetechnology is in the hands of its rival Compulsory licensing lowers the first component and

raises the second Thus, compulsory licensing can have two negative effects on economicwelfare It can reduce welfare in the short run by compelling inefficient licensing It can alsoreduce welfare in the long run by reducing incentives for innovation.”

2.2 Decisions of European courts

To illustrate these difficulties, we discuss a number of competition cases that addressrefusals to license essential inputs protected as intellectual property Some major decisionsclarify under what circumstances European competition authorities consider that a rightholder abuses a position of dominance by refusing to sell or license a protected input to acompetitor

Renault 39 and Volvo 40 cases

The facts of two cases are similar Renault and Volvo had design rights on their models forcar body panels They denied access to their design rights to independent repairers, preventingthem from supplying spare parts The ECJ did not set out the circumstances in which a refusal

to sell is abusive It did, however, provide examples of abusive conduct, pointing out that thelatter can result from the exercise of intellectual property rights They include: (a) thearbitrary refusal to supply; (b) fixing prices at an unfair level; (c) ending the production ofspare parts for models still in circulation The ECJ ruled that the freedom of an IP owner is thecore subject matter of the exclusive right and that the refusal in itself could not be an abuse ofdominant position under Article 82 Refusal to license could be an abuse only if there wasadditional abusive conducts of the types reported above So the ECJ did not condemn thedefendants

Magill 41

In the Magill decision, the ECJ set out for the first time circumstances a refusal to license can

be said to constitute an abuse of dominance42 They include (a) preventing the emergence of anew product for which there is a potential demand; (b) a non-justified refusal to license; and(c) the monopolization by the right’s holder of a secondary market by exploiting power in aprimary market

39 Case C-53/87, ECR 6039, 1988

40 Case C-238/87, ECR 6211, 1989

41 Case T-69/89, ECR II-485, 1991

42 The presentation of this case is inspired from Korah (2001) and Derclaye (2003)

The facts of this case are as follows: Three Irish TV broadcasting stations heldcopyrights on their individual program listings Each station published its own TV guide toinform viewers of its program for the following week Each station also granted a license todaily papers to publish its list of programs one day in advance and the license was grantedfree of charge When Magill decided to publish an all-inclusive weekly guide for all threestations, they sued for copyright infringement and got a preliminary injunction The stationssubsequently refused to grant licenses to Magill and the company filed a complaint with theEuropean Commission The Commission concluded that refusal was in breach of Article 82 Itordered the stations to put an end to their abusive conduct by supplying "third parties onrequest and on a non-discriminatory basis with their individual advance weekly programmelistings and permitting reproduction of those listings by such parties" (89/205/EEC).

This decision was upheld on appeal by the CFI and the ECJ In a famous decision thehighest court said that, although the right to exclude is the substance of the exclusive right, therefusal to license in the special circumstances listed above violates the general obligation ofdominant firms to supply a downstream competitor The ECJ held that although “mereownership of an intellectual property right cannot confer a dominant position”, there was a defacto monopoly over the information produced by the TV stations since they were the onlysource The refusal to supply a license was preventing the emergence of a new product forwhich there was apparently a market demand; and finally there was no justified reason therefusal The refusal to license judged under the heading of the essential facilities doctrine TheCourt did not address the question whether one’s obligation to license should in some ways beaffected by the economic value of the asset protected under intellectual property law Thesocial benefit of the right to prohibit publication of a TV guide is hardly obvious Neither theinspiration behind an artistic creation nor the perspiration behind a research effort is present:there was no significant sunk cost to justify an IP protection The economic rationale may bethat the public wants to be confident that the published programes are reliable This, however,does not explain why the holder should be granted exclusivity, except if there is a risk of error

in the competitors' publications

Much of the litigation to the refusal to license would not take place if intellectualproperty rights were granted on more solid grounds The proliferation of IPRs, many ofdubious background, exacerbates problems at the interface of Intellectual Property law andcompetition policy It would be useful to assign a screening function to the intellectualproperty system by sorting out inventions that would be undertaken without any intellectualprotection from those that would not Without such selection, frivolous intellectual property